Non-Maturity Deposit Modeling:

Balance Sheet Management Considerations

Depository institutions are prone to believe that their deposits have above-average value, that this value is intrinsic and impervious to rising interest rates, above-market asset growth rates and desperate competitors. As a result, they are not prepared for the adverse impact of rising interest rates on earnings and economic value.

Upcoming Workshops

Overview

Numerous risk and profitability management exercises have a common challenge which derives from the need to understand and predict the behavior of non-maturity deposits (NMDs); various risk measures, product management and performance management processes require an explicit assumption about re-pricing and liquidity cash flow dynamics which must be robust to a wide-variety of possible business environments. The challenge relates directly to the absence of contracts or rules which dictate the level and timing of principal and interest cash flows. Assumptions, therefore, must be developed through some sort of empirical modeling process, but while historical analysis is a useful starting point, it is insufficient for most risk and profitability management purposes. This is especially true today given the very low interest rates and excess liquidity that characterized many economies for the better part of the last decade; the observed "stickiness" and low rate-sensitivity of deposits are not likely robust to rising rates. The assumption setting process is also complicated by the impact of other dynamics, such as the institutions’s balance sheet growth objectives, the structure of performance incentives, governance processes as well as changing customer preferences. Material differences in actual behaviors relative to expected behaviors are always possible. Because NMDs are the primary funding source for most depository institutions, any errors in behavioral assumptions can lead to risk and profitability measures that are incorrect and misleading.

Delegates to the workshop will come to understand the various risk and profitability management contexts which give rise to the need for models of NMD behavior as Dr. Green walks through his experience in past cycles building and managing such models. Whether tasked with building a model, validating or auditing one or simply relying upon the output of one, it is imperative to understand the strengths and weaknesses of chosen modeling approaches and the extent to which they acknowledge specific risk and profitability management requirements. To this end, Dr. Green will demonstrate his NMD Model which is unique in its ability to speak simultaneously to a broad range of balance sheet management problems. In addition to quantifying the salient characteristics of rate elasticity, balance decay and balance volatility, the model contains its own FTP engine which is used to produce historical, current and pro forma FTP rates. The FTP rates are used to ensure that key behavioral assumptions feeding risk and profitability management processes are and remain fully aligned.

Highlights

Numerous balance sheet management functions rely upon estimates of NMD behavior; poorly developed behavioral models distort the estimation of IRR, LR and profit attributions, leaving depository institutions ill-prepared for the impact of changes in market interest rates and the price of liquidity on earnings and the value of equity

NMD behaviors are not static; organizations must constantly monitor actual behaviors and reconcile these against expectations that are embedded into forward-looking measures of risk and profitability

Executive management must be conversant with key assumptions around deposit behaviors and how these assumptions relate to assessments of risk and profitability; actions and decisions related to product management must be reconciled against these assumptions

A detailed demonstration of a comprehensive NMD model which simultaneously addresses the modeling requirements of IRR, LR and profitability management; the model has its own FTP engine which produces FTP rates that are fully consist with modeled cash flows

Deposit modeling is more than an empirical modeling exercise; deposit behaviors result from explicit decisions and actions related to product management, therefore product managers must understand how their actions influence re-pricing and liquidity behaviors

Review practical examples and experiences which highlight the need for comprehensive and well-considered NMD modeling practices; many of the examples highlight weakness with many current modeling approaches

The calculation of FTP rates for non-maturity deposits (NMDs) must follow logically from the estimation of their re-pricing and liquidity cash flow characteristics; any discrepancies in these calculations can lead to material inconsistencies in the quantification of IRR, LR and product profitability

FTP rates for NMDs must reflect their intrinsic economic value; improperly estimated FTP rates will lead to performance incentives which may be harmful to the organization; examples of poorly-constructed product initiatives are described in detail

Why You Should Attend

This course describes quantitative and qualitative modeling considerations for developing, implementing, operating and managing behavioral models of NMD behaviors. Unique in its breadth, Dr. Green describes how his approach to deposit modeling has helped his clients be successful in solving a broad range of risk of profitability management challenges in a consistent and robust manner. Dr. Green's two decades of experience in balance sheet management has provided the opportunity observe numerous deposit modeling solutions in action and he describes where many come up short, often leading organizations to draw incorrect conclusions about the value of their deposits, the risk profiles of their organizations and the level of deposit product profitability. For this discussion, Dr. Green leverages his own NMD Model, which includes an embedded FTP engine for calculating historical, current position and pro forma FTP rates; this timeline of FTP rates demonstrates how his approach clearly acknowledges value dynamics through periods of interest rate and liquidity volatility.

The course also addresses how the depository institution (executive management and product managers in particular) can influence behavioral outcomes. There is very little about deposit behaviors that is intrinsic; behaviors result from how products are managed. No matter how valuable a deposit product may have been in the past, its value can be destroyed through aggressive balance sheet balance growth strategies, poorly-structured compensation schema or even the act of simply chasing the market. In order to produce risk and profitability measures which are well-founded AND responsive to changing behavioral dynamics, Dr. Green emphasizes that organizations must monitor behaviors closely to ensure that they remain in line with expectations. This important requirement reveals the inherent weakness of one-off, historical behavioral studies; the monitoring requirement can only be addressed through the development and use of a live model that is specifically designed to support real-time back-testing and validation of behavioral assumptions. Dr. Green is not afraid to ask:

If the behavioral assumptions you have made around your NMDs are incorrect, how long are you comfortable waiting to figure this out?

Organizations must also construct incentive programs which clearly and consistently acknowledge the value of deposits. This cannot be accomplished, for instance, by paying executives, branch managers or tellers for only the volume of deposits or new account openings because volume and value are not the same thing. Further complicating matters, even if an organization understands why deposits represent a key source of value to the franchise, if individual risk and profitability models within the firm are developed and managed independently, there will almost certainly be discrepancies.

Depositories which are truly successful at risk AND profitability management demonstrate a cultural awareness of risk. This trait is embodied in deliberately constructed governance processes which are transparent, logical, consistent and strictly enforced. This attitude compels line of business and product managers (and the systems which are used to support them) to consider a priori potential changes in behaviors across a broad range of interest rate and economic scenarios; outcomes are not left to chance and are not only understood after the fact. Such organizations are well-prepared to deal with rapid and significant changes in the economic and competitive environment.

No one can know exactly how depositors will behave as this next phase of the business cycle unfolds. Depositors have been yield-starved after several years of near-zero interest rates and will likely be quick to take advantage of higher yield opportunities. The days of excess liquidity are over; aggressive balance sheet growth strategies will almost certainly force organizations to pay up for deposits, especially as money market mutual funds have now become a viable option for depositors. Additionally, the rules restricting what banks may pay on commercial transaction accounts have been eliminated. With no recent historical precedent, we cannot yet know how aggressive some organizations will be. The prospect of deposit disintermediation is also being exacerbated by the rise of non-bank financial firms. The days of cheap deposits are nearing an end, and depositor behaviors have the potential to be unlike anything seen in the past.

Who Should Attend

This course is intended to benefit all members of a depository institution’s ALCO committee, ALM managers and their analysts, FTP managers and their analysts, liquidity managers and their analysts, budgeting/forecasting managers, auditors, product managers, product profitability managers, performance management personnel, as well marketing directors. Regulators, central bankers and academics will also benefit from the extensive discussions and applications of theoretical and conceptual modeling frameworks to real-world problems.

Pre-course Questionnaire

A detailed questionnaire will be sent to each delegate to identify their specific training needs and elicit questions and topics they would like to see covered. The completed forms will be reviewed by Dr. Green; he will make every effort to ensure that the course speaks to these requests.

What Past Delegates Have Said About David's Non-Maturity Deposit Modeling Workshop

"Passionate about material and interested in helping institutions." - Georgia's Own Credit Union

"Instructor examples and expertise were instrumental in making this a successful course." - Charles Schwab Bank
"An in-depth, interactive and free-flowing review of deposit modeling, with strong opinions offered by the presenter." - City National Bank